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As we explained last post, the termination for cause provisions of the draft model contract are of two types; breaches of material provisions, and material breaches of other provisions. Today we share the terms enabling the Funder to terminate for cause, interspersed with comments:

7.1 Plaintiff Breach

7.1.1 Material Provisions: The provisions of this contract relating to complete and accurate disclosure of material information about the claim; to cooperation in conducting the claim; and of non-impairment of the claim, the potential award and any proceeds thereof, are the very essence of this agreement and any breach by Plaintiff of those provisions is presumptively material. For the avoidance of doubt, the material provisions are: 2.1.3 and 3.1.3 (relating to disclosures), 2.1.6 (no impairment), and 3.1.2 (cooperation). The presumption of materiality can be rebutted by Plaintiff by showing that such breach did not reduce the potential value of the funder’s Litigation Proceed Rights by more than [10%] compared to the Expected Value of those Litigation Proceed Rights.

These provisions go to the heart of the funder’s risk/reward calculus. Breaches of these provisions most plausibly support claims that the funder would not have invested, or re-invested but for the omission (for disclosure/impairment breaches) or for the unfulfilled promise of future action (cooperation.) The 10% threshold for defining materiality is intended to prevent the funder from claiming a disclosure failure or cooperation failure was material when in fact it was not. That is, if significant damages cannot be traced to the breach, the Funder should not be able to assert the breach was material. Because of the difficulty of proving the connection, however, and to ensure the incentive not to breach is created, it is up to the Plaintiff to prove the breach’s consequences were de minimis.

Whether 10% is the correct threshold is not obvious; arguably it is too high. Securities fraud claims do not require a demonstration of a certain percentage of loss though they do require the security holder to prove the misrepresentation caused the claimed loss. Because the Model Contract is structured as a sale of securities, i.e., securities fraud rules are applicable, the correct percentage should be set with a securities fraud claim in mind. That is, the funder should be able to say, well, if plaintiff’s breach cost me $xxx, that would be a big enough loss that I would seriously consider suing for securities fraud. The termination for cause percentage could then be set as equal to or even smaller than that number, so that breach could give the funder access to remedies without having to pursue a securities fraud claim.

One kind of breach of the material provisions would not ever justify a securities fraud claim and thus should similarly not justify termination for cause: the failure to disclose material, favorable information. The only parties harmed by such failure are the plaintiff, whose pricing is worse than it otherwise would have been, and the investors who did not participate because they did not realize how good the opportunity was. To foreclose the possibility that a Funder would seek to terminate for cause when the plaintiff failed to disclose favorable material information, the contract includes the following:

7.1.1.1 Notwithstanding 7.1.1, failure to disclose material information about the claim that supports the claim, strengthens the claim, or otherwise cannot reasonably be believed to have influenced funder to avoid investing or re-investing in the claim had it been disclosed when required is not a material breach of the disclosure provisions.

Without trying to anticipate all the factual situations under which the breach by the plaintiff of other provisions would damage the value of the claim significantly, this provision is intended to capture them:

7.1.2 Material Breach of Other Provisions: The breach by Plaintiff of any other provision is material if it, by itself, reduces the potential value of the funder’s Litigation Proceed Rights by more than [33%], compared to the Expected Value of those Litigation Proceed Rights.

Finally, some material breaches are inadvertent and can be cured if the Plaintiff is made aware of them. For example, if the Plaintiff failed to authorize the finance transaction properly, such failure may be curable. As a result, the contract contains a notice and opportunity to cure provision[MS4] , while recognizing that some breaches simply cannot be fixed:

7.1.3 Notice of Material Breach by Plaintiff: If Funder believes Plaintiff has materially breached this contract it shall promptly serve notice on Plaintiff. If the breach can be cured Plaintiff then has [30] days to do so. Breaches of the following provisions cannot be cured: the failure to disclose material information covered by 7.1.1.1 at the time of contract execution not and the failure to disclose existing claim impairment at contract execution.

The next post will cover the parallel provisions giving the Plaintiff the right to terminate for cause.